Sunday, August 23, 2015

A PATH-DEPENDENT EXPLANATION OF THE PHILIPPINES’ DEBT-DRIVEN DEVELOPMENT STRATEGY



                       
Bing Baltazar C. Brillo
Associate Professor
Institute for Governance and Rural Development
College of Public Affairs and Development
University of the Philippines Los Ban͂os


This is an Author's Original Manuscript of an article published in “UP Los Banos Journal” on 2014 (vol.8, no.1, pp 47-54).

 


Abstract

The debt-driven development strategy was fundamentally about the massive infusion of external capital via foreign loans to boost the economy. This strategy started in the 1960s when the Macapagal administration decided to take in and utilize external borrowings, specifically the Stabilization Fund offered by the International Monetary Fund (IMF). This decision created a “path” and made foreign debts a key component of the government’s economic agenda. The subsequent Marcos administration, influenced by the established financial ties between the government and international financial institutions, did not only continue the economic strategy but extensively accelerated the external borrowings. This move transformed foreign loans as the engine of the economy. In time, the debt-driven development strategy became an established pattern and was institutionalized since it generated increasing returns and positive feedback that are self-reinforcing. This economic strategy has mutated into a “debt-trap” and has been underpinned by subsequent government laws (specifically, Presidential Decree 1177, Proclamation 50 and Executive Order 292). Consequently, the debt-driven development strategy became path dependent, which is persistent, difficult to reverse and “locks-in” on succeeding governments.

Key Terms: path dependence, critical juncture framework, debt-driven development strategy, Philippine foreign debt, Macapagal administration, Marcos administration


Introduction

A decision made in the past defines and delineates future decisions. Once made, a decision— whether a policy, program or strategy— may develop self-reinforcing incentives. This means that a past decision substantively influences and/or constraints future options which, in effect, makes the chosen policy, program or strategy persistent and difficult to change; and thus, developing into a path dependence. As an analytical concept, path dependence was developed in economics to explain technological evolution, but was later adopted in political science to examine the continuity of institutions and policies. In policy studies, the critical juncture framework became the main strain of path dependence in analyzing the sustainability of policies. The critical juncture framework contends that once a policy is selected, its application/implementation would generate increasing returns and positive feedbacks in time which would operate for the maintenance/continuance of the chosen policy and work against policy reversal (i.e. making policy change very difficult).

For the longest time, the debt-driven development strategy is the standard policy of Philippine governments in promoting economic growth and industrialization. Since its adoption by the administration of President Diosdado Macapagal in the 1960s and eventual institutionalization by the administration of President Ferdinand Marcos in the 1970s, this economic strategy has become an enduring policy sustained by the subsequent government of President Corazon Aquino in the mid-1980s. The persistent pattern has resulted in more and more foreign borrowings by each administration over time. Consequently, the country’s foreign debt has reached alarming proportions that debt servicing has become an economic burden, eating up a substantial portion of the national budget year after year. Despite this, the debt-driven development strategy is expected to continue with no sign of abating. Under this context, this article utilizes the concept of path dependence, specifically the critical juncture framework, to trace the evolution and explain the persistence of the debt-driven development strategy adopted by the Philippine governments.

The Concept of Path Dependence  
           
Path dependence, as an analytical tool, gained prominence when it was used to explain the dominance of the “QWERTY” keyboard, from the vintage typewriter to the sophisticated computers (David 1985 and 1999). The central contention was that the QWERTY keyboard gained ascendancy due to a specific decision made in history— the pioneer makers of typewriters adopted the QWERTY keyboard design.[1] This initial decision would have critical consequences, as it gave the QWERTY keyboard an early lead over other typewriter keyboard designs. As more users preferred a widely used keyboard design, the QWERTY keyboard became the universal standard, making it costly to switch to other keyboard designs and compounding its leadership position. This situation would ultimately redound to path dependence; “locking-in” the QWERTY keyboard as the mainstream keyboard design and making it difficult for other designs to penetrate the market even if they maybe easier to use (see Arthur 1989 and 1994, Puffert 1999).  

The concept of path dependence was principally utilized in political science to examine the development and persistence of institutions and policies. The most common approach under this lineage is the so-called critical juncture framework. The critical juncture framework has three essential components: (1) the antecedent condition which refers to the prevailing situation before a decision is made; (2) the critical juncture which refers to the point of decision among the contingent choices; and (3) the specific trajectory which refers to the established pattern as the consequence of the decision (Collier and Collier 1991). In this arrangement, once a decision is made (i.e. a policy is selected among the alternative choices), it creates an established pattern that limits future choices and endures over time. Increasing returns and positive feedback makes the established pattern persist (Mahoney 2001, Page 2006). Consequently, these self-reinforcing incentives make changing or modifying the status quo policy very costly.

A simple analogy of the critical juncture framework could be seen through “the driver’s dilemma”—  where the driver of a car is at a junction and needs to decide which road to take to get to his destination. Once a road is picked among the alternatives and the longer the driver moves through this road, the greater the probability that he will stay on that road because it would be costly for him to return to the junction to change roads. Since changing roads means a waste of efforts (e.g. time invested in the journey and the time that will be expended in returning to the junction) and resources (e.g. wear and tear on the vehicle and the additional fuel that would be consumed), and risky (i.e. there is no guarantee that the new road is the more efficient route). Thus, these self-reinforcing incentives would strongly induce the driver to stay on the same road, and thus, establishing an “irreversible” path.

There are also other self-reinforcing incentives that work for the continuity of an existing policy (i.e. making it difficult to change). The two most common are: one, the short time horizon of politicians’ time in office; and two, the status quo bias of policies (North 1990, Pierson 2000). The first underscores the disconnect between the actions of politicians which are typically confined to the electoral timetable, and the time necessary to reform or change a policy (including the benefits that will accrue from the change) which usually requires more time (i.e. beyond electoral cycles). This time disconnect creates a tendency for politicians to not change the policy since the implementation and impact of the change are beyond their term of office. The second emphasizes the inherent characteristics of policies which oppose change. By nature, a policy is designed to resist change and last long for stability and predictability. Overall, these factors generate impetuses for the maintenance of the policy as well as impediments for policy change.[2]

Building on the discussions, this study uses the path-dependent approach in examining and explaining the persistence of the debt-driven development strategy in the Philippines. In particular, the critical juncture framework is utilized to elucidate the initiation, intensification and eventual institutionalization of the economic strategy from the Macapagal administration to the Marcos administration.

Establishing the Debt-Driven Development Strategy

The Antecedent Condition. The rise of the nationalist movement characterized post-World War II Philippines, which led to the government’s adoption of protectionist economic policies. Among the main ones were: (1) the import-foreign exchange controls, (2) the import-substituting industrialization (ISI) strategy and (3) the Filipino first policy. The import-foreign exchange controls were adopted by the administration of President Elpidio Quirino (1948-53) to deal with the Balance-of-Payment (BOP) crisis in 1949. This control mechanism was designed to conserve the scarce foreign currency reserve of the country by restricting the access of the private sector to foreign credits and curtailing the importation of consumption goods (Boyce 1990). Although designed as a temporary remedy, the subsequent administrations of President Ramon Magsaysay (1953-57) and President Carlos Garcia (1957-61) adopted and maintained it (Malaya and Malaya 2004). The first policy, import-foreign exchange controls paved the way for the second policy, the import-substituting industrialization (ISI) strategy (Golay 1961, Baldwin 1975). This economic strategy was designed to reduce foreign dependency by promoting economic independence via manufacturing replacements for imported goods. The ISI strategy operated through nationalizing/subsidizing key industries and imposing protectionist trade regulations (Street and James 1982). The Filipino first policy was adopted by the Garcia administration via the National Economic Council’s Resolution no. 204 in 1958. This policy gave Filipinos preferential treatment in all matters connected to the economic development of the country like applying for foreign exchange allocation (Constantino and Constantino 1978, Agoncillo 1990). Apparently, these protectionist policies defined the economic orientation of the Philippine governments in the 1950s.

The Critical Juncture. After winning the 1961 presidential elections, the newly-installed Macapagal administration was confronted by a crucial decision on whether to continue the protectionist policies of the previous administrations or adopt a liberalized economic orientation. The Macapagal administration opted for the latter— a market-oriented development strategy. This decision was influenced by: one, President Macapagal’s personal commitment to the United States’ government which openly supported his run for the presidency (Constantino and Constantino 1978); and two, the economic stagnation and the looming BOP crisis facing the country (Ofreneo, 1991). In reorienting the economy towards the liberalized setup, the government’s first major step was to abolish the import-foreign exchange controls and allowed the Peso to float in the international currency market (Malaya and Malaya 2004). This move was anchored on the understanding that the Macapagal administration would be getting $300 million of financial assistance from the United States government and international financial institutions, mainly through the International Monetary Fund’s (IMF) Stabilization Fund. In this scheme, the Macapagal administration was bestowed an open credit arrangement through external sources which it can use to promote economic growth and address the financial crises.

            The decision of the Macapagal administration to seek external financial assistance made foreign debt a significant component of the government’s economic development strategy. This decision was reinforced by the government’s move to hand over its economic agenda to a group of technocrats that staunchly adhered to the IMF fiscal prescriptions (Constantino and Constantino 1978). As a consequence, the flow of external loans steadily increased and reached $600 million in 1965; a surge from the $150 million foreign debt before Macapagal assumed office (Brillantes and Amarles-Ilago 1994). Thus, the government’s decision to seek external loans firmly placed foreign debt into the country’s financial ledger and made the debt-driven development strategy the principal economic policy.

Persistence of the Debt-Driven Development strategy

The Established Pattern. Although in its nascent phase during the Macapagal administration, the debt-driven development strategy was institutionalized by the Marcos administration which ascended into power after the 1965 elections. The Marcos administration did not only continue the debt-driven development strategy but substantively enhanced the economic policy. The decision to accelerate the external borrowings was considerably facilitated by the government’s established financial ties with international financial institutions and the US government. In turn, this defined the Marcos administration’s economic agenda which was built on the notion that the extensive infusion of external capital will bring about economic growth and industrialization. As a consequence, the country took in massive loans, not only from the international financial institutions but also from foreign governments and private commercial banks. This made external funds the critical source of the domestic economy’s capital needs, and hence, the main engine of the economy (De Dios and Hutchcroft 2003).

The debt-driven development strategy was enhanced by several key factors: the relative ease with which to obtain foreign loans; the deluge of petro dollars in the 1970s (which prompted international commercial banks to aggressively seek clients to unload the funds [Balisacan and Hill 2003]); the foreign debtors pegging the interest at a lower rate than the one prevailing in the international financial market; the declaration of Martial Law in 1972 (which centralized political power that made it easy for the Marcos administration to impose its economic agenda); and the recruitment of technocrats in government (which justified the utilization of external borrowings as a legitimate economic strategy [Fabella1989]). These factors made external loans the standard mode for financing public investments (Bautista 2002); thus, from the 1970s onwards, most of the government’s big economic development projects were funded through foreign borrowings (Boyce 1993, Hutchcroft 1998). Furthermore, the debt-driven development strategy was reinforced in the 1980s when the Marcos administration was confronted by the imminent BOP crisis, the failure of the Export-Oriented Industrialization (EOI) program, the global oil price shock, and the aftermath of the assassination of Senator B. Aquino in 1983. The resilience of the debt-driven development strategy was manifested when the Marcos administration, as remedy, negotiated with its international creditors to restructure its debt payments and launch an economic recovery program premised on acquiring more external borrowings. As a consequence, the country’s aggregate debt progressed significantly from $599 million in 1965 to a staggering $27 billion in 1986 (Freedom from Debt Coalition 1989).

The decision of the Marcos administration to adopt the debt-driven development strategy did not only conform to but substantially reinforce the established pattern. The institutionalization of the debt-driven development strategy became evident when it evolved into a “debt trap,” a condition where the government has no choice but to continue borrowing to sustain a functioning economy[3] (Montes 1992, Brillantes and Amarles-Ilago 1994). In turn, the situation has ramified into a vicious cycle where more foreign loans were acquired to finance the government and to pay for the maturing foreign debts. Moreover, the Marcos administration’s decision to issue Presidential Decree 1177 in 1977 further galvanized the debt-driven development strategy. This law authorized the automatic appropriation for debt service in the annual national budget, effectively making debt service the priority in the budgetary allocation of the government.

The debt-driven development strategy has “lock-in” on the government, as its institutionalization as an economic policy was passed on to the succeeding Corazon Aquino administration.[4] Early on in its reign, the Aquino administration adopted the model debtor strategy to promote the country’s creditworthiness with international financial institutions and foreign investors (Bello 2004). This decision was legally concretized by Proclamation 50 which declares that the Philippine government recognizes all its debts and affirms its commitment to paying them, and Executive Order 292 which upholds Presidential Decree 1177, reiterating anew the automatic appropriation for debt service in the national budget. Thus, these actions firmly reinforced the debt-driven development strategy as an established pattern in the government.

Conclusion

The debt-driven development strategy commenced when the Macapagal administration decided to abandon the protectionist economic policies of the previous administrations and adopt a liberalized economic orientation. By seeking external financial assistance, the Macapagal administration’s decision created a “path” that made foreign debt a key element of the government’s economic policy. The established financial ties between the government and international financial institutions influenced the succeeding Marcos administration, as the government did not only continue the debt-driven development strategy but extensively accelerated it. There was massive infusion of external capital in the economy as the foreign borrowings became the main fuel for economic growth. In time, the path was transformed into an established pattern through a variety of increasing returns and positive feedback, such as the availability of foreign funds, the relative ease with which to get foreign loans, the government becoming populated by technocrats who adhere to the economic strategy, and the transformation of the debt-driven development strategy into a “debt trap” (where foreign borrowings sustain as well as burden the economy). The established pattern was further reinforced and institutionalized by subsequent laws, particularly Presidential Decree 1177, Proclamation 50 and Executive Order 292. Thus, under this context, the debt-driven development strategy is path dependent, making it persistent and difficult to reverse.


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[1] The QWERTY keyboard was adopted primarily to deal with mechanical malfunction and not with efficiency.
[2] Proponents of path-dependent approach have suggested that an exogenous shock or a powerful external impetus (e.g. political scandal, mass protest, serious calamity and financial crisis) is necessary to neutralize the self-reinforcing incentives and disrupt the established pattern, and thus, providing the opening in the move for policy change.
[3] This situation was exacerbated since many borrowed funds were invested poorly which did not translate to sustainable revenues.
[4] The government of President Marcos was toppled in 1986 via the so-called EDSA People Power Revolution.

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